Inside Health

Sharp Increase In Tax Revenue Will Cut Deficit

By EDMUND L. ANDREWS

Published: July 13, 2005

For the first time since President Bush took office, an unexpected leap in tax revenue is about to shrink the federal budget deficit this year, by nearly $100 billion.

On Wednesday, White House officials plan to announce that the deficit for the 2005 fiscal year, which ends in September, will be far smaller than the $427 billion they estimated in February.

Mr. Bush plans to hail the improvement at a cabinet meeting and to cite it as validation of his argument that tax cuts would stimulate the economy and ultimately help pay for themselves.

Based on revenue and spending data through June, the budget deficit for the first nine months of the fiscal year was $251 billion, $76 billion lower than the $327 billion gap recorded at the corresponding point a year earlier.

The Congressional Budget Office estimated last week that the deficit for the full fiscal year, which reached $412 billion in 2004, could be ''significantly less than $350 billion, perhaps below $325 billion.''

The big surprise has been in tax revenue, which is running nearly 15 percent higher than in 2004. Corporate tax revenue has soared about 40 percent, after languishing for four years, and individual tax revenue is up as well.

Most of the increase in individual tax receipts appears to have come from higher stock market gains and the business income of relatively wealthy taxpayers. The biggest jump was not from taxes withheld from salaries but from quarterly payments on investment gains and business earnings, which were up 20 percent this year.

That was similar, though much smaller than a sharp rise in tax revenue during the stock market boom of the late 1990's, which was followed by plunges in revenue when the market bubble burst.

But many independent analysts cautioned that the improvement, though notable, could prove ephemeral and that it did little to eliminate much bigger fiscal problems just over the horizon. ''Lawmakers who allow themselves to be lulled into thinking that the economy is growing its way out of the deficit,'' wrote Edward McKelvey, an economist at Goldman Sachs in New York, ''are unlikely to support the painful measures needed to reach a more lasting solution.''

For one thing, analysts note, federal spending has continued to climb rapidly, about 7 percent this year. Despite cutbacks in many domestic programs, spending has surged for the war in Iraq as well as in certain benefit programs providing health coverage.

In addition, while a lot of the increase in tax revenue flows from the improving economy and higher incomes, part of the jump stemmed from a special factor: the expiration of a temporary tax break that allowed companies to write off their investment in new equipment much more rapidly than normal.

That tax break reduced revenue by about $61 billion in 2004, but it merely postponed taxes that companies would have to pay once their equipment was fully depreciated.

Other financial hurdles may be down the road. Mr. Bush's intention to extend his tax cuts indefinitely, and to add new ones, would drain more than $1.4 trillion from government coffers over the next 10 years.

As the Medicare expansion into prescription drugs begins to take effect, the cost is estimated at about $33 billion in 2006, with increases every year after that. In 2015, the annual cost of the program is expected to be about $137 billion.

A senior White House official cautioned that it was too early to make definitive judgments about whether the tax cuts had fulfilled the promises of ''supply side'' economics, a Reagan era concept that posits a direct relationship between lower tax rates and faster economic growth.

''We need to wait for more data,'' said Ben S. Bernanke, who took over this month as chairman of President Bush's Council of Economic Advisers, at a conference on Tuesday at the American Enterprise Institute.

But Mr. Bernanke said the tax cuts had undoubtedly contributed to economic growth, which in turn bolstered tax receipts.

''One consequence of strong income growth is that we are enjoying higher-than-expected levels of tax collections,'' he said.

Critics of Mr. Bush's fiscal policies said the budget outlook seemed good only in comparison with the dire state of affairs a year ago. Given that the recession formally ended nearly four years ago and that overall growth has been quite strong for the last two years, they said, the budget ought to be in much better shape.

''It's only good if you set the bar at $400 billion,'' said Richard Kogan, a senior economist at the Center on Budget and Policy Priorities, a liberal research organization here. A $300 billion deficit, he said, was ''really bad if you remember that we've recovered from a recession and you think we are at or near full employment.''

Mr. Bush has faced rising budget deficits almost from the moment he took office in 2001. Though the budget had a surplus of more than $100 billion that year, tax revenue plunged as the economy headed into a recession and as Mr. Bush increased military and related spending.

Deficits shot up for each of the next three years, reaching $412 billion last year or, nearly 3.5 percent of the gross domestic product.

Mr. Bush has pledged to cut the budget deficit by 2009 to about $260 billion, and that goal could be within future grasp. If current trends hold, the deficit could amount to less than 3 percent of the gross domestic product -- less than in many West European countries that have been hobbled by slow growth and the heavy cost of supporting social welfare programs.

Democrats, expecting the Republicans to trumpet the good news, said on Tuesday that the long-term fiscal outlook remained almost as grim as before.

The immediate challenge is in the continuing costs of the war in Iraq, which are on track to cross the $200 billion level by the end of this year.

A much bigger problem is the impending retirement of baby boomers, with the oldest in that group eligible for Social Security payments starting in 2008.

Social Security's annual surpluses, which have been running around $150 billion a year, have been a major source of operating cash for the government. But those surpluses will start to decline before the end of the decade, and the program is expected to start running annual deficits in 2017.

Mr. Bush has proposed cutting the growth in future benefits, and has also called for letting people divert some of their payroll taxes to private retirement accounts. House Republicans are pushing a separate proposal to use the Social Security surplus for financing private retirement accounts.

Both proposals would send budget deficits soaring in the next few decades, though supporters say that the government would eventually recoup the money by reducing its benefit costs in the future.

The biggest fiscal threat of all comes from Medicare, the government's health care program for the elderly. Health costs are growing much faster than the economy as a whole, partly because of new technologies and drugs and partly because of the aging population.

''Future presidents and future Congresses,'' said Senator Kent Conrad of North Dakota, the ranking Democrat on the Budget Committee, ''are going to be faced with pressure to drastically cut Social Security and Medicare because of the decisions being made now.''

Chart: ''A Jump in Corporate Payments''
The estimate of the federal budget deficit was reduced because of an unexpected increase in corporate tax revenue.